Good day, and welcome to the Standard Motor Products Third Quarter Earnings Call. [Operator Instructions] Please note today's call is being recorded. It is now my pleasure to turn the conference over to Larry Sills. Please go ahead.

Good morning, everyone, and welcome to Standard Motor Products Third Quarter Call. I am Larry Sills, Chairman of the Board. With me are Eric Sills, President and CEO; Jim Burke, Chief Operating Officer; and Nathan Iles, Chief Financial Officer. What we're trying to do this morning is Eric will review the highlights of the quarter and year-to-date. Jim will go over some of our operations, and Nathan will go deeper into the financial results. Then we'll open for question and answer. So let's go. And just to get us started, I'll turn it to Nathan for the forward-looking statement.

Okay. Thank you, Larry. Before we begin this morning, I'd like to remind you that some of the material that we'll be discussing today may include forward-looking statements regarding our business and expected financial results. When we use words like anticipate, believe, estimate or expect, these are generally forward-looking statements. Although we believe that these expectations reflected in these forward-looking statements are reasonable, they are based on information currently available to us and certain assumptions made by us, and we cannot assure you that they will prove correct. You should also read our filings with the Securities and Exchange Commission for a discussion of the risks and uncertainties that could cause our actual results to differ from our forward-looking statements. I'll now turn the call over to Eric.

Thank you, Nathan, and good morning, everyone, and welcome to our third quarter call. Overall, we're very pleased with our performance in the quarter. We set a record for sales even when compared to a surge in third quarter last year. We were able to consummate an acquisition in Europe with terrific strategic value. And we were able to accomplish this while continuing to navigate the complexities of the ongoing pandemic, including the related supply chain challenges. We achieved sales of over $370 million in the quarter, up nearly 8% from the prior year with both divisions having all-time highs. This marks 5 consecutive record sales quarters, with year-to-date sales up now 17% over 2020. As noted in our press release, our gross margin saw some compression in the quarter, most notably in Engine Management, and there were 2 drivers for this. First, as with many companies, we have been experiencing inflationary headwinds across a host of our costs, including raw materials, labor and transportation. We will be passing these along through price increases starting in the fourth quarter, and we'll, therefore, see recovery going forward. Jim and Nathan will provide some more color on this later on the call. The other element is an ongoing strategic channel shift. As I will discuss in greater detail in a few minutes, we have been dramatically growing our specialized OE business. This business represents 25% of our Engine Management sales in the quarter as compared to 14% of it last year. This OE channel has a different cost structure from our aftermarket business. While it has lower gross margin, this is entirely offset by lower SG&A as there are substantially lesser costs associated with distribution, sales and marketing. And therefore, it has comparable operating margins. All in, we were able to post…

Okay. Thank you, Eric. I will provide a brief update on our supply chain challenges and the associated inflationary pressures. First, on our supply chain. SMP, similar to other manufacturers and distributors, has been challenged procuring our basic raw material and commodity needs, such as semiconductor chips, plastic resins, silicone and metal-based commodities. Many of these components have been placed on allocation with lead times, in some cases, extending 365 days or longer. This results in a substantial strain on our efforts to schedule and manage the production cycle. However, through the benefit of our North American footprint and Poland manufacturing operations, we believe we are better able to manage these challenges than our suppliers, who elect to source the vast majority of their products from China. Being a low-cost basic manufacturer with operations in Mexico, the U.S., Canada and Poland, we are in a far better position to control our own destiny than sourcing finished goods from China for resale. Transportation logistics from Asia have caused significant delivery delays, the impact of container shortages, vessel availability, congested ports on each end, all of which causing havoc within the supply chain. While SMP is not immune to these delays, through a combination of our higher North American and Poland manufacturing footprint and our willingness to invest in inventory, we are better served to meet our customer demand spikes. Our supply chain, manufacturing and distribution operating teams have been creative at finding alternate vendors, alternative materials and alternate ports of entry to improve our competitive position. Our customers have acknowledged these efforts stating SMP as one of their top tier suppliers. In addition, we believe this has been a real differentiator, assisting SMP with new business wins in 2021. One last point on the supply chain has been a shortage of…

Great. Thank you, Jim. The numbers, I'll walk through the operating results for the third quarter and first 9 months and also cover some key balance sheet and cash flow metrics. Looking first at the P&L. Consolidated net sales in Q3 2021 were $370.3 million, up 7.8% versus Q3 last year. And for the first 9 months were $988.9 million, up 16.9% versus last year. Looking at it by segment, Engine Management net sales in Q3 were $247.2 million, up $17.6 million versus the same quarter last year. For the first 9 months, we're up $88.6 million. While these are significant increases, the comparisons are made against a highly volatile year in 2020, and so it's better to compare our results to 2019. On this 2-year stack comparison, Engine net sales were up 14.4% for the quarter and up 7% for the first 9 months, with the increases being a result of successful customer initiatives, new business wins and generally robust market demand. Further, acquisitions made this year contributed sales of $20.5 million in the quarter and $30 million for the first 9 months. Temperature Control net sales in Q3 2021 were $119.1 million, up 7.9% versus the third quarter last year and were up 23% for the first 9 months. And like we said for Engine, it's better to compare our 2021 results to 2019. And on that basis, Temp Control sales were up 34.9% for the quarter and 19.2% for the first 9 months, with the increases mainly reflecting a very long and hot summer selling season as noted before. Turning to gross margins. Our consolidated gross margin in Q3 2021 was down 3 points to 28.4% versus last year, but for the first 9 months remained 0.4 points higher than last year at 29.1%. Looking at the…

Well, thank you, Nathan. And before opening it up for questions, let me just close by again stating that we're delighted with our quarter and the year-to-date, and I'm very proud of how our people performed. Our financial performance has been strong, both in sales and profits. We've been active in M&A with 3 complementary deals this year and have done so while navigating the complexities of the ongoing pandemic, keeping our people safe and managing through supply chain challenges. And I absolutely feel we are a stronger organization for it. We're pleased with the overall state of the industry and of our standing within it, and we are very excited about the future. With that, I will turn it over to the moderator, and we'll open it up for questions.

[Operator Instructions] We'll take our first question from Daniel Imbro with Stephens Inc.

This is Joe Enderlin on for Daniel. So you touched on today that you're going to start passing through costs in the fourth quarter. We were just wondering how your customers responded to your plan to raise prices? And then are you seeing any evidence of the end customer traffic slowing because of these prices going up?

Well, thank you for the questions. And so let me answer the 2 pieces. First, in terms of customer acceptance and responsiveness, I think what we're seeing, and I'm sure you're hearing this from all other suppliers and the distributors is right now, everybody is experiencing the same inflationary pressures. And the sentiment is that as long as all boats rise, it makes sense to be able to accommodate the cost increases. So it's always competitive, but we believe that it's been well received. As it relates to potential impact on demand, I guess, is what you're asking, the vast majority of our products are nondiscretionary items. Your vehicle is down, and you need the part. So in that regard, it's not entirely price sensitive. If you need that ignition oil, you're going to buy that ignition oil. So we don't expect any suppression of demand as a result.

That's super helpful. As a follow-up, I was going to ask, the balance sheet is in good shape today. How much leverage would you be willing to take on to fund acquisitions if the right deal became available?

Yes. Hey, Joe, it's Nathan. So our balance sheet is very strong, as you say. I would say, overall, our capital allocation strategy remains the same. We're disciplined in our M&A outlook. And so we'll focus on the things that make sense for us, but we won't take on any more leverage than what makes sense for the company as a whole. So.

[Operator Instructions] We'll go next to Scott Stember with CL King.

Congrats on the strong results. Just a question on, I guess, your inventory situation on the Engine Management business. You talked about how you've been able to, I guess, outperform other guys because of your manufacturing footprint and where you're sourcing your products from. But could you just talk about how thin your inventories are and potential -- or how much sales are being left on the table just because of what's going on?

Yes. Scott, Jim Burke. Eric pointed out earlier, our fill rates, we're not satisfied where they are. We're doing -- we believe we're doing better. We hear from the customers that are there, and that's a direct reflection of the investment that we've had in inventory and dealing with vendors and the difficulties in supply and product. I would not quantify a significant amount of lost sales because of it. Yes, there's some, but I wouldn't call it significant that's in there because our fill rates, as I said, are not to where we want it to be, but still very strong. I would say we've -- inventory is part of working capital has been a significant increase this year. We ended last year at a low point. The investment that we've made so far has benefited us. But I'd say we're managing through that investment level now, and I would not anticipate replicating any further increases there. Thank you.

Got it. And then on the Engine Management, some structural changes for the gross margin. But assuming price increases go through as you want them, what is the longer term -- basically, the longer-term gross margin expectations? I think in the past, it's been 29% to 30% if I'm not mistaken. Has that changed? That -- it sounds like it just structurally will.

Yes. Scott, this is Nathan. And just to maybe reiterate what I said in my remarks, we think our margins for Engine will recover to the 28% to 29% range in the fourth quarter after some of the pricing comes through. We would expect to sort of stick at that level going into 2022, but certainly have our eyes on the many moving pieces, as I said, inflation and pricing being 2 of those. So we'll just continue to monitor that as we go forward.

Okay. And just lastly on the SG&A side, $66 million in the quarter. You just talked about some reasons why it was up. And I know last year, we were in austerity measures. But how should we look at SG&A or your operating expenses in the fourth quarter and if that run rate will continue into next year?

Yes, Scott. So we expect to continue to have pretty good leverage. I think for the full year, as a percentage of net sales, we'd expect our SG&A to be around the 19% level. And then again, depending on where sales volumes go next year, that would be the baseline for any further improvement.

[Operator Instructions] And we do have another follow-up from Scott Stember with CL King.

Yes, I knew I forgot to ask a question. On Temperature Control, obviously, another very, very strong year. How are we on inventory heading into the slower season and heading into the prebuying season early next year?

Scott, I assume you're referring to customer inventory levels, correct?

Yes. Yes, exactly.

Okay. Well, what we've seen is that they were able to stay pretty healthy really throughout the season to sell in, roughly match the sell through. And so they're coming out into the off-season in pretty healthy stead.

It appears we have no further questions in queue. I'll return the floor to you for any additional or closing remarks.

Okay. This concludes our third quarter call, and we thank you all for attending.

Thank you.

This does conclude today's program. Thanks for your participation. You may now disconnect.